Concept of Separate Legal Entity and Consequences of Corporate Personality
Discuss the concept of separate legal entity and consequences of corporate personality on a company; as part of the discussion present your opinion whether the judiciary can ignore the rule of separate corporate personality and how the said rule will affect group of companies.
Under the concept of separate legal entity, a company will becomes a body corporate that exists separately with its owner and distinct from its individual members and directors. In others word, the corporation is an entity just like human being created using legal and official purpose. A company once created by the law can only be destroyed by the process of law. The company exist in its own capacity and does business, generate revenues, incur losses, hire employees and pay for its own tax. It is better to recognize the company as a separate entity because the owners can enjoy the limited liability and risk based on their investment in stock.
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However, under this concept, the company is treated in its own capacity. It is not human, not a machine, and it cannot operate by itself. Therefore, it must need a group of people of different capacity to manage it ethically and represent it in theirs vested authorities. The separate legal entity has its roots in the landmark case of the English House of Lord in Salomon v. A Salomon & Co Ltd. Aron Salomon is a leather merchant and wholesale boot manufacturer trading on his sole account.
In year 1892, he decided to change his business to a limited company. The company purchase the business for ? 39,000 and ? 0,000 was being transferred into the business as fully paid shares. ?10,000 was paid in debentures and ? 1,000 was received by Aron Salomon to discharge the debts and liabilities during the purchase. A year after its incorporation, the company become insolvent and went into liquidation. The company was set out by the way of counterclaim, inter alia, so that the company was entitled to be indemnified by Aron Salomon against all debt of the company. The court held that Aron Salomon is not personally liable to pay to the creditors. The company is a independent person in law and not a trustee or agent.
Therefore it is liable for the liability itself. There are a few consequences incurred based on the independent legal entity theory. A company is a body corporate and is capable of exercising all the functions of an incorporated company. A company is also capable of suing and being sued. As a company is incorporates under the Act, it will automatically has the perpectual succession, its own common seal and the power to hold land. Corporate personality allow one corporate to act as a single entity for legal purpose. The corporate personality allow the company to sue and being sued, enter into contracts, incur debt and own a property.
The corporate personality is not absolute and it can be treated as the rights or responsibilities of the directors or the shareholders by “piercing the corporate veil”. The effect of the theory of independent legal entity is the property of the company which is a going concern belongs to it and not to its individual members, directors or the shareholders. The principal of law can be related to an English case of Macaura v. Northern Assurance Company Ltd & Ors. The appellant sold the whole timber estate to a company called Irish Canadian Sawmills Ltd. And received pay of 42,000 fully paid shares of ? 1 each in the company.
After the sale, the appellant bought an insurance policy in his own name in covering against the fire on the timber of the estate. After that, the greater part of the estate caught fire but the respondent refuse to pay the appellant by argued that he had no insurable interest towards the estate. Finally, when the appellant appealed, the court held that a sole shareholder has insurable interest towards the company. Applying the theory of independent legal entity, it is held in the case of Lee v. Lee’s Air Farming Ltd that the governing director of one company can validly employ himself as the employee of the company.
Lee started a company called “Lee’s Air Farming Ltd”. Lee held all the shares of the company except one and he employed himself in this company. Next, Lee bought a insurance policies for the benefits of the employees included himself. Lee was killed in a plane crush and his wife claimed the compensation for the personal injury caused to the workers by the reason of employment accident. The claim was opposed by the company stated that Lee cannot be the governing director and the employee at the same time so that he is not liable for the compensation.
The court held that the position of lee as the governing director did not stop him to enter an employment contract with the company. Therefore, Lee’s wife is liable for the claim of compensation. However, the rule of separate corporate personality can be open to abuse and can in certain situations lead to harsh injustice. Therefore, to solve this problem, the judge can lifting the veil of incorporation where those who are responsible will be held personally liable for the acts of the company. For example, a director resigned from a company and signed a contract to not compete with the company he just left for a period of time.
If he set up a company to compete with the previous company within the period of time, technically is the company competing but not the person. In this case, the court may held that the establish of the new company is a fraud and the formal company may take action on the person for breach of contract. As a result, the court would look beyond the legal fiction to the reality of situation. There are some circumstances where the corporate veil can be lifted by the Act. One of the circumstances is reduction of members below the statutory minimum, which is less than two.
Section 14(1) states that incorporation of company requires two or more persons to register their name to the memorandum. The corporate veil might be lifted even if the number of members fall below two, the company still have an independent legal existence. However, the members remained in the company will still liable for the debts of company under section 36. It is only that the members remain after 6 months after the business started can be sued and liable to the payment of debts. The second circumstance is offence relating to financial assistance to purchase shares.
Financial assistance is assistance given by the company on the purchase of its own share or the shares of its holding companies. Once the company or the other people constituted an offence under section 67, the privilege of limited liability of members may be lost. The court may order the convicted person to pay compensation to the company once the company suffered a loss or damage as a result of constitution of offence. Basicly, section 67 involves some prohibitions related to any way of lending, purchasing and dealing of the company own shares by any financial assistance.
Next, the third circumstance is signing of bill of exchange or other similar documents. This circumstance states that when any negotiable documents or any endorsement signed by the officer or any person on behalf of company without mention the company name or formal name, then the person should be liable to the holder of the instrument and also the order of amount. The liability of the officer will not arise when the company paid the amount. Then, the forth circumstance would be issuing of share by directors.
Section 132D prohibits the directors from exercising any power of the company to issue shares without any prior approval of the company in the general meeting. Besides, no provision in memorandum or any article of the company can overwrite the statutory prohibition. When such prohibition applied, any shares issued under it will be void and recoverable of the shares will be given consideration. The directors involved will be liable for the compensation of loss or damage. The recovery must be proceed within three years from the date of issues under the provisions of Limitation Act 1953.
Besides, wrongful trading is also one of the circumstances where the corporate veil can be lifted by the Act. If an officer of company cause any proceedings against the company or the course of winding up the company, the officer may be guilty for an offence under the section 303(3). The knowledge of the officer must be tested at the time when the debt was contracted. When the officer has been convicted to be offense under Section 303(3), the court may order the officer to personally liable to unlimited liabilities for the repayment of part or wholly the debt. On the other hand, fraudulent trading can lifted the corporate veil.
If any business of the company was carried out with intention to defraud creditors of the company or other person or for other fraudulent purpose. In such condition. The court may order the party which carried out the business to be personal liable to any debts or other liabilities of the company without limitations. The application here can be made by liquidator or creditor or contributor of the company. The last circumstance that can lift the company veil is payment of dividends out of capital. The company is not allowed to pay the dividends to its members out of the share capital.
Section 60 states that all dividends can only be paid as part of profits. The directors or officers that pays or permits to pay the dividend, was liable to the creditors of the company. In terms of common law, a contract entered with enemy alien is void for illegality as it is against public policy. The court can lift the corporate veil during war time to investigate whether the company is enemy alien or not. If one company is controlled by enemy alien, it is incapable for suing since the trading which was made by the company might be illegal. In the case of Daimler Co Ltd v. Continental Tyre and Rubber Company(Great Britain) Ltd.
CTR is incorporate in England but all the shares of the company were held by Germans except one is for the British secretary. Besides, the directors were German residents. During the war between England and German, an action was taken to pay for the trade debts. The issue occurred whether CTR can sue and recover a debt in the period of war. The court held that CTR was a enemy alien company and stated that CTR is incapable of suing and payment of debts as it is illegal against the public policy. To determine the control of company, number of enemy alien shareholders and the value of their shareholding is ascertained.
Some of the company use the Salomon principle to commit fraud. As in the case of Aspatra Sdn Bhd & 21 Ors. V. Bank Bumiputra Malaysia Bhd & Anor ,Lorrain Osman is the director of first respondent and the chairman of the board of directors of the second respondent. He was sued by the respondents that he made secret profit in breach of duty as the director of both respondent. Mareva injunction and Anton Piller order is held on Lorrain Osman. The appellant company was held that it can lift the corporate veil so that the assets of the appellant companies could be held or deemed to be the assets of Lorrain Osman.
The third conditions is avoidance of contractual covenants. Independent legal entity cannot be used to circumvent his contractual obligations owed to the other party to the contact. When the new company was set up, this condition will help to make sure that the setting up of the company is not for the purpose of avoiding contract. In the case of Gilford Motor Co Ltd v. Horne & Anor, E. B Horne was a Managing director of Gilford Motor Co. once his employment end, he signed a contract in which he would not do any business which same line with the Gilford motor Co. fter leaving the company.
This is to prevent any customers of Gilford motor Co from being solicit or entice away. After Horne’s employment had terminated, he formed a limited company under his wife name, which is in the same line of business with Gliford Motor Co. Therefore, the court held that the action is try to entice away the customer and Horne is committing breach of contract. The theory of independent legal entity in group enterprise is hard to applied and described because the holding-subsidiary relationship can be quite complex nowsaday.
Most of the formation of group enterprise may due to reasons like commerce or legal sanctity and it is being formed as a network of holdings, cross-holding and circular-holdings. However, the company law states that each company in a group is a separate legal entity. It means that the company posses its own rights and liabilities independently. In the other words, when an individual holds most of the shares in a company, he will get control on the company but the business carry out by the company is not his business. There are some cases applying the principal of independent legal entity in group enterprise such as Goh Hooi Yin v.
Lim Teong Ghee. The plaintiff made an application from court in order to inspect the accounts and take copies of all entries in bank book of its sister companies in assuming that those companies are “one and consist of same directors and identical Memorandum of Association and Articles of Association. The court refuse to accept the applications because it judged that the court must exercise great with such matters. The Act is not always ignore the group phenomenon, instead, the Act is start to more focus on the relationship between the holding-subsidiary relationship and imposed restrictions in their dealings with each other.
Same as the single independent company, the corporate veil also can be pierced in some circumstances. When the corporate veil is lifted, the companies in the same group enterprise will be treated as single economic unit. In the case of Hotel jaya Puri Bhd v. National Union of Hotel, Bar & Restourant Workers and Anor, the hotel appealed that the award of court as an compensation to the restaurant workers employed by the subsidiary of the hotel. The court found out that both the company was under the Managing director, who has authority to control the employees.
Therefore, the hotel is in law with the employees as they were employed by the restaurant and they had no violence to the principle of separate entity as illustrated in Salomon case. So the court held that the hotel and the restaurant are under a single entity. The following case which illustrated the piercing of corporate veil is the case of Tiu Shi Kian & Anor v. Red Rose Restaurant Sdn Bhd. The plaintiff operates “Golden Million Cabaret & Night Club” in the Red Rose Restaurant Sdn Bhd (Red Rose) in the Hotel Shangri-La owned by Hotel
Berjaya Sdn Bhd (Hotel Berjaya). During the renewal of tenancy, The plaintiff get a injunction to prevent the Red Rose from interfere the business. The order is served on Albert Teo chin Kion and Datuk Hong Kim Sui which are the executive and managing director respectively besides the role of directors in Hotel Berjaya. The premises was locked and the plaintiff take legal action on them. It was argued that Hotel Berjaya ha locked the Night Club instead of Red Rose. The court held that the Hotel Berjaya and Red Rose are under a single legal entity and the breach is being recognized.